Friday, August 31, 2012

Updated February 2014Now that the ECB is discussing the possibility of setting a policy of negative interest rates, this article from the New York Fed becomes even more pertinent, particularly as key central bankers around the world have painted themselves into a policy corner.An
interesting article out of the New York Federal Reserve entitled "If Interest Rates Go Negative....Or, Be Careful What You
Wish For" takes a look at the scenario of negative interest
rates and how these rates would impact the economy and consumers.

As shown on
this graph, for each of the eight recessions that America has experienced over
the past five decades, the Federal Reserve has used falling interest rates (in
red) to prod the economy back to life:

Notice that,
since 1980, the background interest rate during expansions (in green) has
dropped to lower and lower levels, most notably in the period since 2008 when
interest rates were pushed to near zero. Despite that, the economy is
barely growing and unemployment remains elevated. This has led some
people to suggest that the Fed should push short-term rates into negative
territory, yet another experiment along with the already ineffective QE and
Twisting.

The Fed
could best accomplish this by charging interest on excess bank reserves rather
than paying interest. The Interest On Excess Reserves or IOER currently
sits at 0.25 percent. It is this rate that is the benchmark for Treasury
Bills, commercial paper and interbank lending. By lowering this rate
further or pushing it into negative territory, banks would have less incentive
to keep deposits with the Fed and may be more willing to loan the funds thereby
stimulating the economy.

According to
the authors of the analysis, Kenneth Garbade and Jamie McAndrews, IOER rates
below negative 0.50 percent would present problems for banks because their
products and services would be used in ways that are not expected. As
cash from money market funds flooded into banks, they would likely be forced to
charge depositors for holding onto their cash, essentially creating a negative
yield. The Bank of New York Mellon has already taken steps toward
charging a fee to depositors with large cash balances as shown here. As well, demand for certain
Treasuries would spike as investors sought yield, pushing the price up and
yields down further, resulting in even greater distortions in the bond market.

Here are
some of the impacts of negative interest rates and tactics that consumers and
businesses may use to avoid losing money on their savings:

1.) Some
analysts suggest that negative rates are not possible since investors will
choose to hold cash. While that may be possible for smaller investors
like you and I, it is not possible for corporations and various levels of
government who would be holding billions of dollars in physical currency.
That said, smaller businesses and individuals who elect to hold cash
would pressure the Treasury Department to print more physical currency as
demand for paper bills rose.

2.)
Special-purpose banks would likely be created. These banks would offer
conventional checking accounts for a fee and would pledge to hold no assets
other than cash, held in a vault. Checks written on these banks would
essentially be a receipt on the cash held by the bank.

3.)
Individuals may choose to make large excess payments to the IRS, counting on
collecting the overpayment the following April. This would avoid losing
money on negative interest unless, of course, the IRS implemented a negative
interest rate policy on overpayments.

4.)
Individuals may also choose to make large excess payments on their credit
cards, running down the balance as they make purchases.

5.) Rather
than depositing checks received from governments, businesses or other
individuals immediately, recipients may find it more prudent to avoid negative
interest rate charges by simply not cashing the checks immediately.

6.)
Consumers and businesses will have more incentives to make payments on
outstanding credit balances quickly over a shorter period of time and receive
payments on such credit balances more slowly over a longer period of time.
This is completely contrary to the current system that demands payment on
credit as quickly as possible. This will pose problems for a system that
has evolved in an environment where "time is money".

As we can
see from this analysis, a Federal Reserve-implemented negative interest rate
environment would result in an intriguing set of issues for the American
economy, the banking sector and consumers. While it is highly unlikely
that such an environment will occur, ten short years ago, no one would have
ever thought that the Fed would have pushed interest rates down to a fraction
of a percent for a three year period.

Thursday, August 30, 2012

An
interesting website, NerdWallet, founded by Tim Chen and
Jacob
Gibson in 2009, has just published its most recent outcome prediction for the 2012 Presidential
election. I realize that everyone and their dog has an analysis that
predicts a November winner but I found this one intriguing. Here is a
summary of Joanna Pratt's analysis.

Let's start
out with what the analysis uses as its baseline.

1.)
President Obama has 201 safe electoral votes.

2.) Mitt Romney
has 181 safe electoral votes.

3.) The
winner needs 270 electoral votes out of 538 total.

There are 12
states with a total of 156 electoral votes that could go to either candidate.
To get the 270 votes, Mitt Romney needs at least 89 of those 156 electoral
votes or 57 percent of the total to win. Here is a chart showing
the 12 states in play, the current polling numbers and the statistical odds of
winning each state:

Right now,
the margin of error in polling is 5.5 percent according to
NerdWallet, a margin of error that was statistically gleaned from the
2004 and 2008 elections.

The computer
simulations run using the current polling results and polling accuracy suggests
that, at this point in time, Mitt Romney will win only 250 electoral votes, a
number that is short of what is needed to win the Presidency. Note, as well, that this is well down from 257 electoral votes just two days ago.

To
summarize, here is a pie chart showing the odds of winning the election based
on NerdWallet's analysis:

Basically,
Mitt Romney's chances of getting the 89 electoral votes that he needs to win is
only 19.7percent, compared to 79.5 percent for the incumbent President. Keep in mind, however, that on November 1st, the odds of Mr. Romney taking the necessary votes was 31.3 percent so, it would appear that the momentum has swung in favour of the incumbent.

Wednesday, August 29, 2012

Nearly every
day, we read some grim news about Europe's economy. The August 2012 edition of the ECB
Monthly Bulletin shows that European households are having a
difficult time. A handful of graphs will show you where the problems lie.

To help keep
the importance of household consumption into perspective, the ECB states that in the first quarter of 2012,
Europe's GDP was 2365.1 billion euros. Of this, household final
consumption expenditures were 1364.3 billion euros or 57.7 percent.

First up,
here is a graph showing annual percentage changes as a percentage of gross
disposable income for household income and consumption growth and savings ratio
:

Real
disposable income declined by 0.5 percent on a year-over-year basis.
Consumption (dashed brown line) grew by a modest 1.9 percent annually,
close to income (solid blue line) growth of 1.8 percent over the same one year
period. The savings ratio (dashed green line) has dropped to near-decade
lows of 13.3 percent, down from nearly 16 percent during the peak of the Great
Recession.

The net
worth of households continues on its downward slide as shown here:

The net
worth of households declined on the back of falling real estate prices; over
the past four quarters, household net worth has declined by 4.9 percent of
gross disposable income. As you can see from the purple line on the
graph, the change in net household worth has swung to the negative side for the
first time since the end of the Great Recession. The household
debt-to-assets ratio reached a historical peak of 14.5 percent as a result of
relatively low savings and decreases in the value of non-financial assets.

Despite massive
intervention by the ECB and the Bank of England, households definitely are not
feeling the wealth effect from their domestic stock market portfolios:

Consumer
confidence is, not surprisingly, "below its long-term average" as
shown on this graph:

This signals
that consumers simply are not willing to spend as is reflected in shrinking total retail sales data (solid blue line).

Lastly,
let's look at Europe's employment picture. In June, the unemployment rate
across the Eurozone hit 11.2 percent, an increase of 1.2 percentage points over
a year earlier despite the fact that this is supposed to be a post-recession
recovery. These two graphs show that further job losses are anticipated in both manufacturing and non-construction employment and that the losses appear to be accelerating:

Here is a
graph showing the unemployment situation:

Unemployment
expectations for 2012 stand at 11.2 percent, rising to 11.4 percent in 2013 and
falling back slightly to 10.8 percent in 2014, hardly stellar and well above what both the United States and Canada are experiencing and expecting.

For those
who are still working, here is a graph showing how compensation in some
countries continues to drop when compared to the euro area:

You will
notice that workers in both Greece and Spain have seen their wages fall back to
the levels that they were at in 2002 and that Ireland is back to levels that it experienced back in 2004.

When you see
all of this data in one place, it make you realize why things in Europe look so
grim. What is even more frightening is that in today's global economy,
all of our markets are intertwined. The United States and the European Union have the
largest bilateral trade relationship in the world with the U.S. investing three
times as much as they invest in all of Asia and the EU investing eight times
the amount in the U.S. that they invest in India and China. Approximately
15 million jobs are linked to the transatlantic economy. In the case of Canada, the EU is its second most important
trading partner after the United States, accounting for 10.4 percent of
Canada's total external trade. Thirty-four percent of Europe's imports
are sourced from Canada.

From this
posting, I hope that you will realize how important the health of Europe is to
the rest of the world's economy and, in particular, how important it is that
Europe's households remain fiscally secure. After all, in our consumer-driven
economy, households are key.

Tuesday, August 28, 2012

Fiserv has
now released its analysis of the United States housing market. Here are a few of the salient points
from their summary accompanied by my usual commentary.

Let's open
by looking at the most recent Case-Shiller chart of national home price
indices showing that things finally appear to be turning a corner:

Fiserv notes that the U.S. housing market is finally showing some signs of
stabilizing. Home prices in 151 markets or 39 percent of the 384
metropolitan areas tracked by Fiserv Case-Shiller showed an increase in the
first quarter of 2012 compared to a year earlier. That noted, price
declines of 1.9 percent were noted on average across the U.S. and are forecast
to decline another one percent over the next twelve months. On the upside, prices are expected to
appreciate by 5 percent between Q1 2013 and Q1 2014!

Price
appreciation was noted in Detroit, and Michigan (up 8.6 percent) and Miami,
Florida (up 6.4 percent), however, this has to be taken into context since
these areas have seen peak to trough price declines well in excess of 50
percent. In sharp contrast, double digit price decreases were noted in
Atlanta, Georgia (down 17.4 percent), Las Vegas, Nevada (down 7.4 percent) and
Memphis, Tennessee (down 4.7 percent), all on a year-over-year basis, largely because these markets are still flooded with foreclosure properties.

Fiserv notes that inventories of single-family homes has dropped below 2.5 million,
the lowest level since 2004. This
shrinking supply is nudging prices upwards, however, the large number of
homeowners with negative equity is impacting many markets. Many markets that experienced price crashes
are now seeing far lower inventories of foreclosures, putting modest upward pressure
on prices.

The 35 to 40
percent drop in prices over the past 6 years has resulted in the ratio
of the price of a median single family home to median family income at its
lowest point since 1991. In fact, for those lucky Americans that are not
underemployed or unemployed, the mortgage payment for a median-priced home now
consumes only 12 percent of a median family's income, the lowest percentage
since record-keeping began in 1971. From FRED, here is a graph showing
housing affordability back to 1980, noting, of course, the recent drop in
affordability:

So we can
all better understand this graph, here's how FRED measures housing
affordability:

"Value of 100 means that a family with the median income
has exactly enough income to qualify for a mortgage on a median-priced home. An
index above 100 signifies that family earning the median income has more than
enough income to qualify for a mortgage loan on a median-priced home, assuming
a 20 percent down payment. For example, a composite housing affordability index
(COMPHAI) of 120.0 means a family earning the median family income has 120% of
the income necessary to qualify for a conventional loan covering 80 percent of
a median-priced existing single-family home. An increase in the COMPHAI then
shows that this family is more able to afford the median priced home."

Fiserv notes
that the biggest risk to the housing market is the stalling world economic
recovery and the risk of another political impasse in Washington over debt and
deficit reduction.

Fiserv
suggests the following:

1.) Investors
and buyers looking for home price appreciation should head west since eight of
the top ten markets projected to grow fastest in the next year are located in
Oregon, Idaho, California and Washington.

2.) The
housing market in Florida continues to be bleak with eleven of the 20 metro
areas seeing home prices falling the most over the next year. The state is home to four of the ten worst
markets and four of the ten best markets based on projected changes in housing
prices over the next five years. Orlando is projected to see an additional 6.8 percent drop over the next year and Jacksonville will see an additional drop of 3.3 percent.

Fiserv
projects that between the first quarter of 2013 and the first quarter of 2014,
358 of the 384 metropolitan housing markets (or 92 percent of the total) will
see price increases.

Only time, the unemployment situation, interest rates, the political games in Washington, a slowing world economy and the debt crisis in Europe will tell whether Fiserv’s
projections are wanting.

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.